[Draft] Letters to Policy Makers-I: Piling the Forex Reserve
Is it a Poverty of Aspiration or Imagination?
Dear Mr. Sanjeev Sanyal
Greetings. Forgive my writing to you out of the blue. Although we have not formally met, we are not strangers.
I have decided to write letters to policymakers, sharing my observations about India and the world. This is also a pedagogical tool to help my students learn a thing or two and appreciate the beauty of standard economics.
Ever since I saw your podcast with Sadguru, I have been rooting for you.
You have been in the news for talking about the ‘poverty of aspiration’ of the UPSC aspirants. Your distaste for any equilibrating force, it seems, is so intense that out of your learned helplessness, you see a poverty of aspiration when no such poverty exists; what I have in mind is the curious case of educated unemployed in India. In many conversations with my elders, the aversion of Indians to getting their hands dirty always comes out as one of the critical reasons for a lack of creativity among engineers working in India.
Most educated Indians, it seems, want to think about the ineffable Brahman!
I know some faculty in the US who regret that they never appeared for the UPSC exams out of their fear of failure; otherwise, they feel jealous of the bureaucrats and their power to bring about change in their beloved India.
It’s not the poverty of aspirations that plagues India; it is the poverty of imagination that has kept it behind.
I must tell you all that I love your work and am aware of the sacrifices you have made by leaving a plush corporate job for the love of your country. I almost read anything that you write. I like those who know how to love; however, any intense indulgence, devoid of the right dosage of viveka, would make the lovers see what they want.
But lately, you have displayed a predilection for some make-believe mental trap—a kind of exceptionalism—when you say that you run the Indian economy or, for that matter, that you are helping (re)build Indian civilization. Don’t get me wrong; you are quite capable of doing all that, but vocalizing your responsibility does not sound good; a statement conveying the gargantuan responsibility on your shoulder with a generous dose of gratitude would have sounded far better. I personally feel envious of you for the seva that you are providing in the service of Ma Bharati!
I can put on a Hayekian hat and deploy the canonical law of ignorance derived from the celebrated fallacy of knowledge: Those who say that they run the economy don’t know what they are talking about (Quite like what we found in one of the Upanishads: Those who say they know it, they know not).
Before the COVID-19 pandemic, financial engineers and consultants from big organizations and corporations used to believe that they were running the world. And when the push came to shove, we all saw who all were running the world.
Piling the Forex Reserve
Had you been paying attention, India wouldn’t have been mindlessly building its forex reserve.1
Just look at the interest rate differential between India and the US: it is now at a historic low, only 125 basis points. Rather than feeling relaxed that India would be saved from the racket of profiteering financial vultures and that there would be more scrutiny from International financiers, India has chosen to pile on forex reserve.
While there’s no universally agreed-upon figure for the optimal level of forex reserves for India, no doubt that the RBI and Indian policymakers might be continuously assessing various indicators and risks to determine an appropriate level of reserves. Take a moment and look at the graph below a BIS paper:
A quick glance at the paper suggests that India might have at least 100 billion extra reserves in its Forex coffers. Counterfactually speaking, for a growing economy that should ideally have been at least half as big as China, we are leaving at least 5 trillion USD on the table. After leveraging the extra 100 billion USD in our domestic market, there would have been worth at least half a trillion USD in investment.
A sharp mind like Sridhar Vembu has started to notice lazy ways to grow India. India does not have to take the route that other countries took to grow without factoring in the negative externalities amassing forex reserves on the workings of the global economy; quite a non-dharmic way of managing an economy, don’t you think?
It was in Daniel Kahhneman’s famous book “Thinking Fast, Thinking Slow” that I first learned how to get things right while following a wrong map. I hope India continues to remain as fortunate as the lost army platoon in the Swiss Alps in Kahneman’s book.
We all need some metrics or other metrics to navigate the world around us. One of the metrics is the forex exchange reserve. Like the survivors of the Great Depression, India burnt badly in the wake of the implosion of Soviet Russia and continues to dread running out of the forex reserve to finance its imports.
Today, India is a lower middle-income country holding the fourth-largest FX reserves in the world.
Had you really been running the Indian economy, you would have realized the opportunity cost of not investing in India (a certain ‘unnecessary’ portion of the forex reserve), which is severely capital-scarce. Capital scarcity in India means a higher return on capital. Ever since the Heckscher-Ohlin formalized their two-factor economy, we know that the US and the advanced economies are capital-rich countries.
When India (and other countries like China and Japan) hold a large reserve, it opens a low-cost capital spigot for the American economy, which is already very capital-rich. This leads to a severe distortion of the relative price of its non-traded goods and services.
Non-traded goods and services are what they are; they are the sinkhole absorbing the excess investment coming into the US, leading to an increase in their prices. The increase in the price of non-traded goods and services is reflected in the higher prices of education, health, and national security in the US, leaving less resources for other priorities like infrastructure in the US. It also misallocates the global capital away from the region where it will be more valued, except that those regions’ poor institutional quality keeps investors super wary of deploying their capital there.
If one thing that a multi-millennia-long civilisation like India teaches the world is this: Everything is connected to everything else!
Had you been running the Indian economy, you would have been aware of the distortionary effect of India not being able to attract and hold onto a sufficient amount of global capital (Remember, India is a mere 3% of the world economy). Attracting investment in plucking the low-hanging (less risky) fruits is easy; the tough job will be to improve the quality of institutions, which critically depends on the loopy framework of the institutions and the quality of human capital resources.
I once asked my class to imagine how big a billion was. They didn’t know how to express their comprehension in terms of a real object except that it was nine zeros after one.
India has probably 1.5 billion people; many can’t even comprehend this number. India is a shockingly complex society. Any meaningful stab at managing India would start by acknowledging the complexity of India, which will imbue a person or a team with vismaya (awe and wonder) and then vinamrata (humility)—VATV. Sans VATV, no one can manage the gargantuan Indian economy; forget about running it. All that can be done is help Indians make sense of the beast that the Indian economy is!
[….TO BE CONTINUED]
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Disclaimer: The opinions and thoughts expressed here reflect only my personal views and not of the institution where I work.
Nothing I have written here is set in stone. I am putting these ideas to start a conversation and bring people to discuss and debate the issues captured here. Give me feedback, and it will help me learn. I will keep updating this article.
https://www.forbesindia.com/article/explainers/indian-forex-reserves/87581/1